Arcane Topics in Economics and Philosophy, Interspersed with Various Distractions

June 08, 2011

Pundits on the right are converging on a story. Here's John Podhoretz:

By now it is clear to everyone that the Obama administration bungled the 2009 stimulus package. The dispute now is over the reasons for its failure. The conventional wisdom is coalescing around a view crystallized in a column by Mr. Conventional Wisdom himself, Charlie Cook of the National Journal: “The administration’s initial response, the much-maligned economic-stimulus package, was far too modest and unfocused.”

Cook is a rational analyst, so it is striking that he is able to advance an argument that is, on its face, nothing short of demented. The idea that the 2009 stimulus, which cost $840 billion, could have been less “modest” and more “focused” does violence to the facts of very recent American history and to the arugments made for the stimulus by its advocates at the time.

Even at its “far too modest” size, the stimulus was, by leagues, the costliest such effort in American history. Its astounding price tag was justified during the debate over its passage by the fact that there was a genuine economic emergency that had to be addressed. And the mere fact of addressing it with enormous public resources was, we were told, enough to do the trick almost on its own. The central point of taking emergency measures, we were told, was precisely not to focus them but to cause them to wash over the economy as a whole.

How many times during that emergency were we reminded of the supposed wisdom of John Maynard Keynes, who wrote in 1930 that it was enough to employ a man to perform any task at hand to create the conditions for macroeconomic growth? Simply “to dig holes in the ground,” Keynes wrote, “paid for out of savings, will increase, not only employment, but the real national dividend of useful goods and services.” This is the famous “multiplier effect” we also heard so much about, according to which $1 in government spending would blossom into $3 of value for the entire economy. In effect, we were told by the most enthusiastic believers in the magic of the multiplier effect, that for $840 billion in spending, we’d get more than $2 trillion in economic activity.

It’s also important to remember that the stimulus wasn’t the first bite at the apple... The notion that Congress could have passed a stimulus bill twice the size of the one that did—Paul Krugman’s idea—was then and is now preposterous. Obama’s stimulus was as large as it could possibly have been, and the parlous results indicate it was vastly larger than it should have been.

The growing consensus is that Obama’s economic policies have failed, and precisely in the ways that those skeptical of the stimulus predicted.

The policies of the Obama administration have led to the weak condition of the American economy. Growth during the coming year will be subpar at best, leaving high or rising levels of unemployment and underemployment.

The drop in GDP growth to just 1.8% in the first quarter of 2011, from 3.1% in the final quarter of last year, understates the extent of the decline. Two-thirds of that 1.8% went into business inventories rather than sales to consumers or other final buyers. This means that final sales growth was at an annual rate of just 0.6% and the actual quarterly increase was just 0.15%—dangerously close to no rise at all. A sustained expansion cannot be built on inventory investment. It takes final sales to induce businesses to hire and to invest.

The picture is even gloomier if we look in more detail...

How has the Obama administration contributed to this failure to achieve a robust and sustainable recovery?

The administration's most obvious failure was its misguided fiscal policies: the cash-for-clunkers subsidy for car buyers, the tax credit for first-time home buyers, and the $830 billion "stimulus" package. Cash-for-clunkers gave a temporary boost to motor-vehicle production but had no lasting impact on the economy. The home-buyer credit stimulated the demand for homes only temporarily.

As for the "stimulus" package, both its size and structure were inadequate to offset the enormous decline in aggregate demand. The fall in household wealth by the end of 2008 reduced the annual level of consumer spending by more than $500 billion. The drop in home building subtracted another $200 billion from GDP. The total GDP shortfall was therefore more than $700 billion. The Obama stimulus package that started at less than $300 billion in 2009 and reached a maximum of $400 billion in 2010 wouldn't have been big enough to fill the $700 billion annual GDP gap even if every dollar of the stimulus raised GDP by a dollar.

In fact, each dollar of extra deficit added much less than a dollar to GDP. Experience shows that the most cost-effective form of temporary fiscal stimulus is direct government spending. The most obvious way to achieve that in 2009 was to repair and replace the military equipment used in Iraq and Afghanistan that would otherwise have to be done in the future. But the Obama stimulus had nothing for the Defense Department. Instead, President Obama allowed the Democratic leadership in Congress to design a hodgepodge package of transfers to state and local governments, increased transfers to individuals, temporary tax cuts for lower-income taxpayers, etc. So we got a bigger deficit without economic growth.

A second cause of the continued economic weakness is the president's emphasis on increasing tax rates. Although Mr. Obama grudgingly agreed to continue the Bush tax cuts for 2011 and 2012, his budget this year repeated his call for higher tax rates on upper-income individuals and multinational corporations. With that higher-tax cloud hanging over them, it is not surprising that individuals and businesses do not make the entrepreneurial investments and business expansions that would cause a solid recovery.

A third problem stems from the administration's lack of an explicit plan to deal with future budget deficits and with the exploding national debt. This creates uncertainty about future tax increases and interest rates that impedes spending by households and investment by businesses. The national debt has jumped to 69% of GDP this year, from 40% in 2008. It is projected by the Congressional Budget Office to reach more than 85% by the end of the decade, and to keep rising after that. The reality is even worse since ObamaCare alone will cost more than $1 trillion in its first 10 years. The president's boast that his health legislation would not "add a dime" to the national debt was possible only by combining that increased spending with proposed new taxes and with projected cuts in Medicare spending that will never occur...

The economy will continue to suffer until there is a coherent and favorable economic policy. That means bringing long-term deficits under control without raising marginal tax rates—by cutting government outlays and by limiting the tax expenditures that substitute for direct government spending. It means lower tax rates on businesses and individuals to spur entrepreneurship and investment. And it means reforming Social Security and Medicare to protect the living standards of future retirees while limiting the cost to future taxpayers.

Martin Feldstein seems to have more faith in stimulus in general than Podhoretz, but thinks the "multiplier" is less than one (or less than zero, depending on how you define it). Which also looks bad for Keynesian theory. And Jonah Goldberg piles on:

"Now, my administration has a job to do as well, and that job is to get this economy back on its feet," President Barack Obama declared on July 14, 2009, in Warren, Mich. "That's my job, and it's a job I gladly accept. I love these folks who helped get us in this mess and then suddenly say, well, this is Obama's economy. That's fine. Give it to me."

OK. It's yours.

The unemployment rate then was 9.5 percent. It's now 9.1 percent, well above the 8 percent cap that the administration advisers projected under the stimulus bill. But that's not the amazing part. According to a White House report written by economic advisers Jared Bernstein and Christina Romer in January 2009 in support of the bill, if we had passed no stimulus package at all, the unemployment rate would have topped out at around 8.8 percent in the last quarter of 2010.

If only.

Instead, we got Obama's vital "investments." Since his speech in Warren, we've spent another $2.8 trillion in borrowed money. Presumably, we could have cut the unemployment rate by four-tenths of a percentage point more cheaply than that?

Meanwhile, we've accrued a total of $3.7 trillion in debt on Obama's watch, while losing 2.8 million jobs. That doesn't sound ideal either.

But what do I know?

The more salient point is that Obama acts like he knows everything. From Day One, this White House has been cocksure about how to get us out of the economic ditch. In every major relevant speech, Obama has stuck with a consistent message: We know what to do and the Republicans don't. "I will not sacrifice the core investments we need to grow and create jobs," Obama insisted yet again in his April budget speech...

No president "runs" the U.S. economy, but this president talks like he does more than any I can remember. And yet, none of his economic promises or predictions has panned out.

Obama deserves all this for his failure to deal with the long-term budget deficit if nothing else. But Keynesian theory also deserves it. In particular, the "multiplier" idea needs to bite the dust. Keynes argued that if the government spends $1, someone will get that $1, save say 10%, spend $0.90, someone else will get that $0.90, save say 10%, spend $0.81, so the total spending will be a lot more more than the original $1. Wrong. (a) Savings don't just disappear, in a healthy economy they will be invested. (b) Savings rates are endogenous, and if people see that the government is borrowing on an enormous scale, they'll save more to offset the anticipated tax increases. In the short run, since some people are credit-constrained, more government spending may raise total spending, in the short run. But it might leave it constant, or even-- because other people, who are not credit-constrained, anticipate paying more than their fair share of the extra future taxes and raise savings by more than the government raises spending-- reduce it. In any event it is not likely to raise it by much. And in the long run it just distorts the economy and makes us poorer. If there are ways to spend that raise long-run GDP, fair enough. It might be a good idea to concentrate that spending in bad times. But generally, fiscal stimulus just doesn't work. We shouldn't really have expected it to.

Comments

I have to say that I think there's tremendous waste in the defense supply chain, and there's probably no more waste anywhere else in the budget. Granted, a thoroughgoing Keynesian would say it doesn't matter if the spending is wasted, but I'm not, so I dismiss that defense. Thus, I don't think stimulus spending on the military would have been a good idea. It's probably not even doable, considering supply constraints. Not really a major point, there; just a note in response to Feldstein.